This paper addresses the entrepreneurial problem of determining endogenously the optimal size of a firm in a competitive market environment, when the production possibilities interact with the labor organization and the governance of the firm. It has been observed by Rajan and Zingales (2001) that at the root of most enterprizes generating economic surplus is an entrepreneur with a unique critical resource such as an idea, good customer relationships, a new tool, or superior management technique. We represent that unique resource by two concepts: a production outcome function specifying the various production possibilities from which to select one, and the firms governance, specifying the management of transactions and agency relations in the firm when realizing the chosen production technology. The firms governance (or rather the entrepreneurs governance) specifies roles or positions within the firm and the agency relations connecting these roles and positions. The governance is adapted to the technology and to the size of the firm. The interaction between these two concepts, the technology and the governance, determines the productivity of positions and of coalitions of positions for workers.

We follow the seminal paper of Alchian and Demsetz (1972) who state that production is in principle a collective effort, see also Hart and Moore (1990) and Ichiishi (1993). Therefore we use a cooperative game theoretic model in which coalitions or teams of workers can generate a production outcome when they are coordinated by their managers. The technology is a set of production outcome functions, each adapted to the products or services supplied, and to the amounts supplied, but invariant for the characteristic degree of complementarity or substitution between the various positions within the firm. A choice of production affects the organization and the governance of the firm.